Employment Related Securities/Share Buy Back

Employment Related Securities/Share Buy Back

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I know its the thorny and vexed area of ERSs but I can't find a commentary on the following scenario (which links ERSs and distributions) which cannot be that uncommon as share buybacks will often be a mechanism to remove minority shareholders - given the company usually has the cash.

Am I right in thinking I have a capital loss (and a claim under Section 574)?
A (lets say the finance director) subscribed for restricted securities in 2005 for 20% of the share capital of X Ltd (not a client of mine back then so no 431 election) for £7,000. Assume that the UMV was £10,000 and the MV was agreed at £8,000 (but remember no election so A has an immediate charge on £1,000 and an IUP of 20% rather than £3,000).

After 2 years he agrees to leave and the company buys back the shares at £100,000 (agreed as market value). (Section 219 can't apply not held for 5 years) so a distribution under Section 209.

Ignoring ERS the answer is simple - distribution of £93,000 and tax to pay of £23,250 (assume its all at 40%). And no capital loss or gain.

But what happens with ERS when £20,000 is chargeable to income tax in 2007 as employment income and income of £1,000 was taxed in 2005.

Is there a capital loss of £21,000 (£100,000 less £93,000 (taxed as a distribution) £1,000 (2005 charge) less £20,000 (2007 charge) less £7,000 (base cost).

As A subscribed for the shares is the capital loss available under Section 574.

Therefore A is saddled with a distribution of £93,000 and an ERS charge of £20,000 on the same 'income' - but the benefit of a capital loss of £21,000 (Section 574). However is 20% too large for Section 575 for the buy back to a 'bargain at arm's length for full consideration'. OR have I missed something that reduces the distribution?

Mike Bell

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By AnonymousUser
17th Apr 2007 17:58

I was about to say that distributions are taxed ..
.. in priority basically as dividends due to section 716A ITEPA, when I realised that I'd be wrong and have been in the past. Section 716A only applies to income taxed under certain parts of ITEPA and the relevant parts, part 3 and part 7 are not among them. So the issue of section 716A is a red-herring even though I gather Andrew Thornhill thinks otherwise, but I'd have to cave in to Andrew Gotch and others on this one. Don't know how I could possibly have missed it.

Anyway, to get to the point, I'd first want to be sure that we actually are talking about restricted securities because if the employee is able to realise market value - which he is presumably doing - then it looks like whatever restriction is implied does not affect the MV and therefore one of the legs of s423 is not met. Therefore the shares are not restricted and incidentally, SV may ignore personal restrictions and only look at restrictions which are inherent in the shares, though it is easy to get mixed up here. For the employment income charge under s62 you would take account of all restrictions, as it's the money's worth value which is point - not the MV under the statutory definition under s421 ITEPA/s272 TCGA, so all restrictions are taken into account. But if the articles allow the shares to be realised at MV or more based upon the statutory definition the shares will not be restricted.

So it's not clear to me that you would have a charge based upon the IUP but if the price exceeds MV based upon the statutory defintion i.e. taking into account minority discounts you could have a charge under Chapter 3D.

Any amount chargeable to income tax as emmployment income should increase the CGT cost andf since any amount not taxable as employment income would be taxable under Chapter 3 of Part 4 of ITTOIA I'd have thought you would have a CG loss available for a claim under s574. There was a very good article in Taxation a few weeks ago by Nicholas Stretch on the interaction of the ERSs and CG rules and as I reacll there are some problems - charges under Chapter 3D may not count in this respect but if the charge was under Chapter 2 it might. I'll need to refresh my memory on this and may post a further comment.

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By AnonymousUser
18th Apr 2007 11:11

As I was saying last night ...
... I think we are quite clear that any amount charged to income tax is excluded from the consideration for CGT purposes, under s37 TCGA. Since all the consideration is excluded either as employment income or Sch F, the CGT proceeds must be nil and so you must have a loss.

If indeed the shares are restricted there could be a charge on the buy-back, though there are one or two exceptions in s424 - one of which is if the shares are required to be transferred where employment ceases as a result of 'misconduct', which may include being a bad leaver.

I can't say I've previosly given any thought to what happens in a buy-back situation - if shares are restricted and the same restrictions apply on disposal the result of the formula in s428 will often be nil because OP will reflect those restrictions. OP is based upon UMV-AMV/UMV immediately after the chargeable event. In a buy back the shares will be cancelled and so cease to exist but whether that state of affairs obtains immediately after the chargeable event or when the shares are actually cancelled is not a question I can answer - you could run past the Share Schemes Unit and you can often discuss on the phone. If there is an OP then this will reduce or eliminate the charge. Assuming OP is nil and there is a charge, then s119A TCGA will deem the amount of income chargeable to be part of the acquisition cost. for CG.

There could still be a charge under Chapter 3D though because the charge under s426 is based upon UMV which is MV without restrictions but applying minority discounts. If the price represents fair value this will often be based, pro rata, upon the value of the whole company and so may exceed UMV. If there is a Chapter 3D charge this does not seem to add to the cost for CGT - this is confirmed in Nicholas' article and he gives an example as to why that should be so.

Can't see why in principle why a s574 claim may not succeed except it seems slightly odd that the claim would include an amount which was not actually subscribed for the shares but is deemed to be part of the acquisition cost. Even so, I'd work through ss574 - 576 in detail as I note that relief is excluded is it is not an arm's length bargain for full consideration. I'll have to leave someone else to pick up that as I don't know how HMRC would interpret arm's length in relation to a buy-back but this can't be the first time the point has arisen.

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